How did Illinois tax canned software, custom software, exempt software licenses, and maintenance agreements under ST 11-0042-GIL?

Plain-English summary

Illinois generally taxed canned software regardless of how it was delivered, while custom software prepared to a customer's special order might not be a taxable retail sale. The requester asked about canned, custom, partly customized software, computer hardware, and maintenance contracts.

A license of canned software could avoid Retailers' Occupation Tax only if it met all five criteria in Regulation 130.1935(a)(1), including:

• a written agreement signed by the licensor and customer;
• restrictions on duplication and use;
• restrictions on licensing, sublicensing, or transfer without the licensor's permission and control;
• a replacement or archival-copy policy supported in the required manner; and
• destruction or return of all copies at the end of the license period, with the regulation's rule for perpetual licenses.

Checking a box to accept internet license terms did not satisfy the signed-written-agreement requirement. If any criterion was missing, a canned-software license remained taxable.

For maintenance, a separately sold optional agreement generally was not a taxable transaction, although the service provider owed Use Tax on property transferred during service. Canned-software updates were fully taxable. If an agreement bundled taxable updates with support or other services and did not separately state and tax the updates, the whole agreement was taxable. By contrast, support, maintenance, and updates governed by a license satisfying all five criteria were not subject to Retailers' Occupation Tax.

The GIL did not specifically decide the treatment of partly canned and partly custom software or whether the seller's hardware qualified for a manufacturing exemption.

What this means for you

Document how the software was created and audit every license criterion. Electronic delivery alone did not make canned software nontaxable, and click-to-accept terms did not meet the signature test described in this letter. On maintenance invoices, separately identify taxable canned updates unless the software and updates are governed by a fully qualifying license.

Common questions

Q: Was downloaded canned software taxable?
A: Yes. The letter says canned software was taxable regardless of delivery method.

Q: Did clickwrap acceptance satisfy the license signature requirement?
A: No. The agreement had to contain the written signatures of both licensor and customer.

Q: What happened when taxable canned updates were bundled with services?
A: If the update charges were not separately stated and taxed, the whole maintenance agreement was taxable as canned software.

Subject

Computer Software

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2011.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2011/st-11-0042.pdf

Original ruling text

ST 11-0042-GIL 05/26/2011 COMPUTER SOFTWARE
This letter concerns computer software maintenance agreements. See 86 Ill. Adm. Code
130.1935. (This is a GIL.)

May 26, 2011

Dear Xxxxx:
This letter is in response to your letter dated April 25, 2011, in which you request information.
The Department issues two types of letter rulings. Private Letter Rulings (“PLRs”) are issued by the
Department in response to specific taxpayer inquiries concerning the application of a tax statute or
rule to a particular fact situation. A PLR is binding on the Department, but only as to the taxpayer
who is the subject of the request for ruling and only to the extent the facts recited in the PLR are
correct and complete. Persons seeking PLRs must comply with the procedures for PLRs found in the
Department’s regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General Information Letter
(“GIL”) is to direct taxpayers to Department regulations or other sources of information regarding the
topic about which they have inquired. A GIL is not a statement of Department policy and is not
binding on the Department. See 2 Ill. Adm. Code 1200.120. You may access our website at
www.tax.illinois.gov to review regulations, letter rulings and other types of information relevant to your
inquiry.
The nature of your inquiry and the information you have provided require that we respond with
a GIL. In your letter you have stated and made inquiry as follows:
I’m writing to inquire about calculating sales tax on sales to companies in your state.
We sell machinery equipment [sic] used in the manufacturing process for glass
windows, repair parts and customized software. Our only physical location is in STATE.
Our orders are obtained by salespeople visiting the customers and by phone orders.
In billing our customers I would like to know if the following are taxable and at what rate:
•

canned or prewritten software

•

custom and customized software

•

partially canned/ partially custom software

•

computer hardware

•

maintenance contracts

Each of these items is separately referenced on the invoices.

Please reply to the below and send a brochure on sales tax for our records.
If you need further clarification, please contact me.

DEPARTMENT’S RESPONSE:
The Illinois Retailers' Occupation Tax Act imposes a tax upon persons engaged in this State in
the business of selling tangible personal property to purchasers for use or consumption. 35 ILCS
120/2; 86 Ill. Adm. Code 130.101. In Illinois, Use Tax is imposed on the privilege of using, in this
State, any kind of tangible personal property that is purchased anywhere at retail from a retailer. 35
ILCS 105/3; 86 Ill. Adm. Code 150.101. These taxes comprise what is commonly known as "sales"
tax in Illinois. If the purchases occur in Illinois, the purchasers must pay the Use Tax to the retailer at
the time of purchase. The retailers are then allowed to retain the amount of Use Tax paid to
reimburse themselves for their Retailers' Occupation Tax liability incurred on those sales. If the
purchases occur outside Illinois, purchasers must self assess their Use Tax liability and remit it
directly to the Department.
Generally, sales of “canned” computer software are taxable retail sales in Illinois. Sales of
canned software are taxable regardless of the means of delivery. For instance, the transfer or sale of
canned computer software downloaded electronically would be taxable. However, if the computer
software consists of custom computer programs, then the sales of such software may not be taxable
retail sales. See 86 Ill. Adm. Code 130.1935(c). Custom computer programs or software must be
prepared to the special order of the customer.
Charges for updates of canned software are fully taxable pursuant to Section 130.1935. If the
updates qualify as custom software under Section 130.1935(c), they may not be taxable. But, if
maintenance agreements provide for updates of canned software, and the charges for those updates
are not separately stated and taxed, then the whole agreements would be taxable as sales of canned
software.
If transactions for the licensing of computer software meet all of the criteria provided in
subsection (a)(1) of Section 130.1935, neither the transfer of the software nor the subsequent
software updates will be subject to Retailers' Occupation Tax. A license of software is not a taxable
retail sale if:
A)
B)
C)

D)

E)

It is evidenced by a written agreement signed by the licensor and the customer;
It restricts the customer’s duplication and use of the software;
It prohibits the customer from licensing, sublicensing or transferring the software to a
third party (except to a related party) without the permission and continued control of the
licensor;
The licensor has a policy of providing another copy at minimal or no charge if the
customer loses or damages the software, or permitting the licensee to make and keep
an archival copy, and such policy is either stated in the license agreement, supported by
the licensor’s books and records, or supported by a notarized statement made under
penalties of perjury by the licensor; and
The customer must destroy or return all copies of the software to the licensor at the end
of the license period. This provision is deemed to be met, in the case of a perpetual
license, without being set forth in the license agreement.

Please note that it is very common for software to be licensed over the internet and the
customer to check a box that states that they accept the license terms. Acceptance in this manner

does not constitute a written agreement signed by the licensor and the customer for purposes of
subsection (a)(1)(A) of Section 130.1935. To meet the signature requirement for an exempt software
license, the agreement must contain the written signature of the licensor and customer. A license of
canned software is subject to Retailers' Occupation Tax liability if all of the criteria set out in 86 Ill.
Adm. Code 130.1935(a)(1) are not met.
In general, maintenance agreements that cover computer software are treated the same as
maintenance agreements for other types of tangible personal property. See 86 Ill. Adm. Code
130.1935(b). The taxation of maintenance agreements is discussed in subsection (b)(3) of Section
140.301 of the Department’s administrative rules under the Service Occupation Tax Act. See 86 Ill.
Adm. Code Sec. 140.301(b)(3). The taxability of agreements for the repair or maintenance of
tangible personal property depends upon whether charges for the agreements are included in the
selling price of the tangible personal property. If the charges for the agreements are included in the
selling price of the tangible personal property, those charges are part of the gross receipts of the retail
transaction and are subject to tax. In those instances, no tax is incurred on the maintenance services
or parts when the repair or servicing is performed. A manufacturer’s warranty that is provided without
additional cost to a purchaser of a new item is an example of an agreement that is included in the
selling price of the tangible personal property.
If agreements for the repair or maintenance of tangible personal property are sold separately
from tangible personal property, sales of those agreements are not taxable transactions. However,
when maintenance or repair services or parts are provided under those agreements, the service or
repair companies will be acting as service providers under provisions of the Service Occupation Tax
Act that provide that when service providers enter into agreements to provide maintenance services
for particular pieces of equipment for stated periods of time at predetermined fees, the service
providers incur Use Tax based on their cost price of tangible personal property transferred to
customers incident to the completion of the maintenance service. See 86 Ill. Adm. Code
140.301(b)(3). The sale of an optional maintenance agreement or extended warranty is an example
of an agreement that is not generally a taxable transaction.
If, under the terms of a maintenance agreement involving computer software, a software
provider provides a piece of object code (“patch” or “bug fix”) to be inserted into an executable
program that is a current or prior release or version of its software product to correct an error or
defect in software or hardware that causes the program to malfunction, the tangible personal property
transferred incident to providing the patch or bug fix is taxed in accordance with the provisions
discussed above.
In contrast to a patch or bug fix, if the sale of a maintenance agreement by a software provider
includes charges for updates of canned software, which consist of new releases or new versions of
the computer software designed to replace an older version of the same product and which include
product enhancements and improvements, the general rules governing taxability of maintenance
agreements do not apply. This is because charges for updates of canned software are fully taxable
as sales of software under Section 130.1935(b). (Please note that if the updates qualify as custom
software under Section 130.1935(c) they may not be taxable). Therefore, if a maintenance
agreement provides for updates of canned software, and the charges for those updates are not
separately stated and taxed from the charges for training, telephone assistance, installation,
consultation, or other maintenance agreement charges, then the whole agreement is taxable as a
sale of canned software.
If all the criteria listed in subsection (a)(1) of Section 130.1935 are met, then neither a
transaction involving the licensing of that computer software nor the subsequent software updates for

that software will be considered a taxable retail sale subject to Retailers’ Occupation and Use Tax.
See 86 Ill. Adm. Code 130.1935(a)(1)(A)-(E).
Assuming a license of software meets the requirements of subsection (a)(1) of 86 Ill. Adm.
Code 1935, any charges for support, maintenance or updates of the licensed software provided
pursuant to the qualified license agreement would not be subject to Retailer’s Occupation Tax,
whether or not the charges for support, maintenance or updates of the licensed software are billed
pursuant to the terms of the license agreement or the terms of a separate agreement as long as the
software updates are subject to the provisions of the qualified license agreement.
I hope this information is helpful. If you require additional information, please visit our website
at www.tax.illinois.gov or contact the Department’s Taxpayer Information Division at (217) 782-3336.
Very truly yours,

Richard S. Wolters
Associate Counsel
RSW:msk